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Capital Budgeting : NPV and IRR methods

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Veronica Tanner, the president of Tanner Enterprises, is considering two investment opportunities. Because of limited resources, she will be able to invest in only one for them. Project A is to purchase a machine that will enable factory automation; the machine is expected to have a useful life of four years and no salvage value. Project B supports a training program that will improve the skills of employees operating the current equipment. Initial cash expenditures for Project A are $100,000 and for Project B are $40,000. The annual expected cash inflows are $31,487 for Project A and $13,169 for Project B. Both Investments are expected to provide cash flow benefits for the next four years. Tanner Enterprise's cost of capital is 8 percent.

a. Compute the net present value of each project should be adopted based on the net present value approach?

b. Compute the approximate internal rate of return of each project. Which one should be adopted based on the internal rate of return approach?

c. Compare the net present value approach with the internal rate of return approach. Which method is better in the given circumstances? Why?

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Solution Summary

Solution evaluates the given investment proposals by NPV and IRR methods.

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Please refer attached Excel file for format and formulas.

a. Compute the net present value of each project should be adopted based on the net present value approach?

Let us tabulate cash flows associated with Project A
Year Cash Flow PV
n Cn =Cn/(1+8%)^n
0 -100000.00 -100000.00
1 31487.00 29154.63
2 31487.00 26995.03
3 ...

Solution provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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